The FDR Framework is the backbone for a 21st century financial system. Under this framework, governments ensure that every market participant has access to all the useful, relevant information in an appropriate, timely manner. Market participants have an incentive to analyze this data because they are responsible for all gains and losses.

Friday, July 26, 2013

In his Reuter's blog, Felix Salmon establishes the standard for judging the quality of a country's financial regulation.

Here’s a quick and dirty way of judging the quality of your country’s financial regulation: to what extent do you create and impose tougher-than-international standards?

By their nature, international standards are the lowest-common-denominator.

Individual countries can and should extend them and create their own rules; when those rules turn out to work well, sometimes the international community will start adopting them more broadly....

Please re-read Mr. Salmon's standard for judging the quality of a country's financial regulation and his observation about how rules that work well are copied.

In the 1930s, the US adopted the FDR Framework as the basis for its financial system. The FDR Framework combines the philosophy of disclosure with the principle of caveat emptor (buyer beware).

US adoption of the FDR Framework was best exemplified by the 1930s Securities Acts that created the SEC and required that all publicly traded securities disclose all the useful, relevant information in an appropriate, timely manner so that market participants could independently assess this information and make a fully informed decision.

As a result of the Securities Acts, the US had the highest regulatory standards and became know for having the most transparent financial markets.

And why wouldn't your want to have the most transparent markets?

Finance is based on the idea that when market participants have all the useful, relevant information in an appropriate, timely manner they can do a better job of assessing the risk of a security and assign it a higher cost than a similar security that is opaque. So why would any country want to put itself at a disadvantage by having its participants in the real economy pay more to access funding?

The financial crisis exposed the "myth" that US markets were still transparent.

Rather than continue to set tougher than international standards, over the last 30 years the US regulators decided in areas like derivatives to join the race to the bottom. As a result, large areas of the financial system became opaque.

While this opacity was very good for bank profitability and banker bonuses, this opacity was very bad for all the other market participants.

Overall, I’d say the US is not doing a great job on the regulatory front.

Dodd-Frank created a lot of noise, but ultimately was much less important than Basel III; what’s more, the banks are now driving the rule-making process so as to effectively neuter most of it.

Confirmation of your humble blogger's observation about the true intent of the Dodd-Frank Act.

Meanwhile, in lots of other corners of the regulatory universe, you can see the forces of capture at work: one prime example is the way in which the FHFA — the regulator for Fannie Mae and Freddie Mac — has hired a prominent insurance-industry lobbyist to help it regulate the very insurers he not only used to represent, but still represents.

The fact is that regulation is one of those things that doesn’t have a natural political constituency: rich banks are good at lobbying against it, while there are no effective or well-resourced lobbyists on the other side....

Please re-read the highlighted text as Mr. Salmon makes a very important point about the lack of a permanent, effective lobby for regulation and transparency.

However, a permanent lobby for regulation should not be needed.

Please recall that under the FDR Framework, it is the government's responsibility for ensuring transparency. It was well recognized at the time the FDR Framework was adopted that a lack of transparency resulted in a systemic financial crisis, the Great Depression.

Under the Securities Acts, the government must ensure that all the useful, relevant information is disclosed in an appropriate, timely manner.

Please note the Securities Acts do not say most of the useful, relevant information. The Acts say "all" the useful, relevant information. Government is told to error on the side of disclosing too much information.

Please note the Securities Acts do not say useful, relevant information to all market participants. They say all the useful, relevant information. This ensures that information that experts could use as part of their assessment of the risk of a security is made available. Again, government is told to error on the side of disclosing too much information.

Please note the Securities Acts do not say that the government should perform a cost/benefit analysis when it is ensuring that all the useful, relevant information is disclosed in an appropriate, timely manner.

It was known at the time the Securities Acts were passed and has been shown with the current financial crisis that the cost of a systemic financial crisis is far greater than the cost of providing all the useful, relevant information in an appropriate, timely manner.

The benefit of having transparency and not having another systemic financial crisis far outweighs the cost of providing transparency. This is why there is no need for a permanent lobby to tell the government that it needs to ensure there is transparency.

About this blog

A blog on all things about Wall Street, global finance and any attempt to regulate it. In short, the future of banking and the global financial system.

This blog will be used to discuss and debate issues not just for specialists, but for anyone who cares about creating good policies in these areas.

At the heart of this blog is the FDR Framework which uses 21st century information technology to combine a philosophy of disclosure with the practice of caveat emptor (buyer beware).

Under the FDR Framework, governments are responsible for ensuring that all market participants have access to all the useful, relevant information in an appropriate, timely manner. Market participants have an incentive to use this data because under caveat emptor they are responsible for all gains and losses on their investments; in short, Trust but Verify.

This blog uses the FDR Framework to explain the cause of the financial crisis and to evaluate financial reforms like the ABS Data Warehouse.